- August 26, 2021 at 10:42 am #633012accountguyMember
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1) Since WACC is the cost of raising finance (i.e. capital) such as in your lecture WACC was 12.51% that means the company has to pay 12.51% out of its total capital raised from both shareholders & debtholders?
Let’s say if we have raised finance of $1m (part from equity & part from debt) then we have to pay ($1m x 12.51%) = $125,100 return to the shareholders & debtholders every year?
2) Is it true also that we assume that if we start a new project & needed investment (or Finance) from investors then we have to return them 12.51% for every new project. The WACC would remain the same for every new project by the company but isn’t it too unrealistic?
3) Since the WACC is the rate onto which investment appraisals projects are evaluated BUT what is the purpose of discount cashflows by the rate of WACC.August 26, 2021 at 3:47 pm #633041John MoffatKeymaster
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1. Effectively yes, although we never use that fact (see (3) )
2. It is only realistic if the gearing is kept the same and if the risk of the new project is the same as the existing risk of the company.
3. If there is a positive NPV when discounting at the WACC then it means that the project is giving a return in excess of the WACC and is therefore worthwhile.
1 and 2 are both explained in detail in my lectures on CAPM (together with gearing and ungearing betas), on Modigliani and Miller, and on finding a project specific cost of equity.
3 is explained in my lectures on the different methods of investment appraisal (even though it is basic assumed knowledge from Paper MA).
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